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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2001
Commission file number 0-30218
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TIME WARNER TELECOM INC.
(Exact name of Registrant as specified in its charter)
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Delaware 84-1500624
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
10475 Park Meadows Drive
Littleton, CO 80124
(Address of Principal Executive Offices)
(303) 566-1000
(Registrant's Telephone Number, Including Area Code)
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Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Class A Common Stock, $.01 par value
Indicate by check mark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. YES [X] NO [_]
Indicate by check mark if disclosure of delinquent filer pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [_]
As of February 28, 2002, the aggregate market value of the Registrant's
voting stock held by non-affiliates of the Registrant was approximately $276.5
million, based on the closing price of the Company's Class A common stock on
the Nasdaq National Market on February 28, 2002 of $5.70 per share.
The number of shares outstanding of Time Warner Telecom Inc.'s common stock
as of February 28, 2002 was:
Time Warner Telecom Inc. Class A common stock--48,799,191 shares
Time Warner Telecom Inc. Class B common stock--65,936,658 shares
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CAUTION REGARDING FORWARD-LOOKING STATEMENTS
This document contains certain "forward-looking statements," within the
meaning of the Private Securities Litigation Reform Act of 1995, including
statements regarding, among other items, the Company's expected financial
position, business, and financing plans. These forward-looking statements are
based on management's current expectations and are naturally subject to risks,
uncertainties, and changes in circumstances, certain of which are beyond the
Company's control. Actual results may differ materially from those expressed
or implied by such forward-looking statements.
The words "believe," "plan," "target," "expect," "intends," and
"anticipate," and expressions of similar substance identify forward-looking
statements. Although the Company believes that the expectations reflected in
such forward-looking statements are reasonable, it can give no assurance that
those expectations will prove to be correct. Important factors that could
cause actual results to differ materially from the expectations described in
this report are set forth under "Risk Factors" in Item 1 and elsewhere in this
report. Readers are cautioned not to place undue reliance on these forward-
looking statements, which speak only as of their dates. The Company undertakes
no obligation to publicly update or revise any forward-looking statements,
whether as a result of new information, future events, or otherwise.
TELECOMMUNICATIONS DEFINITIONS
In order to assist the reader in understanding certain terms relating to
the telecommunications business that are used in this report, a glossary is
included following Part III.
PART I
Item 1. Business
Overview
Time Warner Telecom Inc. (the "Company") is a leading fiber facilities-
based provider of metropolitan and regional optical broadband networks and
services to business customers. The Company delivers broadband data, dedicated
Internet access, and local and long distance voice services in 44 metropolitan
markets in the United States as of December 31, 2001. The Company's customers
are principally telecommunications-intensive businesses, long distance
carriers, Internet service providers ("ISPs"), incumbent local exchange
carriers ("ILECs"), wireless communications companies, and governmental
entities. During 2001, the Company expanded its local and regional networks
into the western United States through the acquisition out of bankruptcy of
substantially all of the assets of GST Telecommunications, Inc. ("GST"). The
Company also activated networks in five additional markets during 2001. As of
December 31, 2001, the Company's networks covered 16,806 route miles,
contained 758,060 fiber miles, and offered service to 10,685 buildings served
either entirely by the Company's facilities ("on-net") or through the use of
facilities of another carrier to provide a portion of the link ("off-net") in
21 states.
The Company's principal executive offices are located at 10475 Park Meadows
Drive, Littleton, Colorado 80124, and the telephone number is (303) 566-1000.
Time Warner Cable (now a unit of AOL Time Warner Inc.) began the Company's
business in 1993. During the last few years, the Company's business has
changed substantially with an exclusive focus on business customers, including
carriers and governmental entities, and a rapid expansion into switched
services and geographic areas beyond the Time Warner Cable footprint.
In July 1998, the Company was reorganized into a limited liability company,
Time Warner Telecom LLC ("TWT LLC"), and conducted an offering of $400 million
principal amount of 9 3/4% Senior Notes due July 2008. In the transaction,
referred to as the "Reorganization," Time Warner Inc. (now wholly owned by AOL
Time Warner Inc.), MediaOne Group, Inc. (now wholly owned by AT&T Corp.), and
Advance/Newhouse Partnership either directly or through subsidiaries, became
the owners of all of the limited liability company interests in TWT LLC.
In May 1999, in preparation for the Company's initial public offering, TWT
LLC was reconstituted as a Delaware corporation through the conversion of TWT
LLC's limited liability company interests into common stock of the newly
formed corporation, Time Warner Telecom Inc. This transaction is referred to
as the "Reconstitution." Also in May 1999, in conjunction with the
Reconstitution, the Company completed an initial public offering ("IPO") of
20,700,000 shares of Class A common stock at a price of $14 per share.
As a result of the IPO, the Company has two classes of common stock
outstanding, Class A common stock and Class B common stock. Holders of Class A
common stock have one vote per share and holders of Class B common stock have
ten votes per share. Each share of Class B common stock is convertible, at the
option of the holder, into one share of Class A common stock. Currently the
Class B common stock is collectively owned directly or indirectly by AOL Time
Warner Inc., Advance Telecom Holdings Corporation, and Newhouse Telecom
Holdings Corporation (collectively, the "Class B Stockholders").
MediaOne Group, Inc. ("MediaOne"), a former holder of Class B common stock,
completed an underwritten offering on May 1, 2000 of 9,000,000 shares of Class
A common stock of the Company, 8,987,785 of which were converted from shares
of Class B common stock. The Company did not receive any proceeds nor did its
total shares outstanding change as a result of this transaction. On June 15,
2000, MediaOne merged with AT&T Corp. ("AT&T") and the Class B common stock
previously beneficially owned by a MediaOne subsidiary became beneficially
owned by AT&T. In June 2001, AT&T converted its remaining 6,289,872 shares of
Class B common stock into Class A common stock.
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Business Strategy
The Company's primary objective is to be a leading provider of superior
telecommunications services through advanced networks in its service areas to
medium- and large-sized businesses. The key elements of the Company's business
strategy include the following:
Leverage Existing Fiber Optic Networks. The Company has designed and built
local and regional fiber networks to serve geographic locations where
management believes there are large numbers of potential customers. As of
December 31, 2001, the Company operated networks that spanned 16,806 route
miles and contained 758,060 fiber miles. In addition, the Company operates a
fully managed, fiber-based nationwide Internet protocol ("IP") network to
provide the capacity and high quality level of service increasingly demanded
by its customers. That network's capacity was expanded in 2001 and ranges in
throughput capacity from OC-3 to OC-48, depending on the specific route. The
Company's IP backbone includes long haul circuits leased from other carriers.
Management believes that the Company's extensive broadband network capacity
allows it to:
. increase orders substantially from new and existing customers while
realizing higher gross margins than non-fiber facilities-based carriers;
. emphasize its fiber facilities-based services rather than resale of
network capacity of other providers and extend its services both locally
and regionally; and
. provide better customer service because the Company can exert greater
control over its services than its competitors that depend on off-net
facilities.
As of December 31, 2001, the Company completed its previously announced
plan to launch service in five new markets during 2001. The Company plans to
increase penetration in existing markets and does not currently intend to
expand into additional new markets. The Company continues to extend its
network in its present markets in order to reach additional commercial
buildings directly with its fiber facilities. In addition, the Company has
deployed new technologies such as dense wave division multiplexing ("DWDM") to
provide additional bandwidth and higher speed without the need to add
additional fiber capacity.
Expand Service Offerings. The Company provides a broad range of switched
services throughout its service area. The Company utilizes high-capacity
digital end office switches that enable the Company to offer both local and
toll services to its customers. The Company has also installed "softswitches"
that enable the switching of voice calls over an IP and local area network
("LAN") infrastructure in certain markets. The softswitches are capable of
providing digital trunks and Primary Rate Interface ("PRI") services. The
Company expects to be able to provide other voice services over IP during
2002.
Data services are increasingly important to the Company's targeted end user
and carrier customer base. In particular, the Company believes that the demand
for high-speed, high-quality LAN and wide area network connectivity using
Ethernet protocol will continue to grow over the long term. The Company
expects this demand will grow in support of specific applications such as
website hosting, e-commerce, intranet, and Internet access. The Company will
continue to deliver high-speed traditional transport services (e.g., DS-1, DS-
3, and OC-n) through its fiber optic networks, but will also focus on the
delivery of next generation data networking and converged network services,
meaning voice and data applications delivered over a common network
infrastructure. The Company anticipates that the converged network will be
capable of providing applications such as virtual private networking, hosted
web and e-mail services, and new applications such as unified messaging. The
Company believes the key to the evolution of the converged network is delivery
of management services along with network service so that medium and small
business customers in multi-tenant buildings the Company serves can rely on it
to manage the network 24 hours-a-day, 7 days-a-week.
Target Business Customers. The Company operates networks in metropolitan
areas with high concentrations of medium- and large-sized businesses,
including other carriers. These businesses are potentially high-volume users
of the Company's services and are more likely to seek the greater reliability
provided by an advanced network such as the Company's. To drive revenue growth
from these customers, the Company expanded
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its direct sales force. In addition, in order to achieve further economies of
scale and network utilization, the Company is targeting smaller business
customers in buildings the Company already serves where it can offer a package
of network services that may not otherwise be available to those customers. As
a result of weakness in the carrier sector, the Company has sought to broaden
its revenue base by an increased focus on end user (non-carrier) customers and
a focus on established carrier customers.
Interconnect Service Areas. The Company groups the service areas in which
it operates into geographic clusters across the United States. The Company
selectively interconnects certain of its existing service areas within
regional clusters with owned or leased fiber optic facilities. The
interconnection of service areas is expected to increase the Company's revenue
potential and increase margins by addressing customers' regional long
distance, voice, data, and video requirements.
Utilize Strategic Relationships with AOL Time Warner Inc. and its
Affiliates. The Company has benefited from and continues to leverage its
relationships with Time Warner Cable, one of the largest multiple system cable
operators in the U.S., by licensing and sharing the cost of fiber optic
facilities. This licensing arrangement allows the Company to benefit from Time
Warner Cable's access to rights-of-way, easements, poles, ducts, and conduits.
See "Certain Relationships and Related Transactions." By leveraging its
existing relationship with Time Warner Cable, the Company believes that it can
benefit from existing regulatory approvals and licenses, derive economies of
scale in network costs, and extend its existing networks in a rapid,
efficient, and cost-effective manner. Furthermore, management believes that
the strong awareness and positive recognition of the "Time Warner" brand name
contributes to its marketing programs and sales efforts by distinguishing it
from its competitors. In addition, the Company has entered into agreements
with various units of AOL Time Warner Inc., to provide switched, dedicated,
data and Internet services to those units.
Continue Disciplined Expenditure Program. The Company increases operational
efficiencies by pursuing a disciplined approach to capital expenditures. This
capital expenditure program requires that prior to making expenditures on a
project, the project must be evaluated to determine whether it meets stringent
financial criteria such as minimum recurring revenue, cash flow margins, and
rate of return. Until the economy improves, the Company expects that capital
expenditures will generally be limited to building entries, electronics, and
distribution rings based on specific revenue opportunities in existing
markets, as well as upgrades to its back office systems. In addition, the
Company's disciplined spending approach allowed it to adjust operating expense
spending appropriately as revenue growth declined in 2001, thus maintaining
strong margins.
Services
The Company currently provides its customers with a wide range of
telecommunications services, including dedicated transport, local switched,
long distance, data and video transmission services, and high-speed dedicated
Internet access services. The Company's dedicated services, which include
private line and special access services, use high-capacity digital circuits
to carry voice, data, and video transmissions from point-to-point in multiple
configurations. The Company provides advanced video transport services such as
point-to-point, broadcast-quality video to major television networks as well
as to advertising agencies and other customers. Switched voice services
offered by the Company use high-capacity digital switches to route voice
transmissions anywhere on the public switched telephone network. In offering
its dedicated transport and switched services, the Company also provides
private network management and systems integration services for businesses
that require combinations of various dedicated and switched telecommunications
services. Data transmission services provided by the Company allow customers
to create their own internal computer networks and access external computer
networks and the Internet. Internet services provided by the Company include
dedicated Internet access, website and e-mail hosting, and Ethernet and
optical transport services for business customers and local ISPs.
Dedicated Transport Services
The Company currently provides a complete range of dedicated transport
services with transmission speeds from 1.544 megabits per second to 9.953
gigabits per second to its carrier and end user customers. These services
4
can be used for voice, data, image, and video transmission. The Company offers
the following dedicated transport links:
. POP-to-POP Special Access. Telecommunications lines linking the points
of presence ("POPs") of one interexchange carrier ("IXC") or the POPs of
different IXCs in a market, allowing the POPs to exchange transmissions
for transport to their final destinations.
. Interexchange Carrier Special Access. Telecommunications lines between
customers and the local POPs of IXCs.
. Private Line. Telecommunications lines connecting various locations of a
customer's operations, suitable for transmitting voice and data traffic
among customer locations.
. Metropolitan and Regional. Each transport service is available on the
Company's metropolitan fiber networks. Most are also available between
cities on the Company's inter-city, regional networks, now reaching 29
major markets.
. Transport Arrangement Service. Dedicated transport between the Company's
equipment collocated within local exchange carrier ("LEC") central
offices and the IXC POP designated by end user customers. The
arrangement can transport either special access or switched access, and
gives end user customers competitive choice for reaching IXCs.
Each service uses high-capacity digital circuits and can carry voice, data,
and video transmissions with flexible configurations and a variety of circuit
capacities:
. Broadcast video TV-1. Dedicated transport of broadcast television
quality video signals over fiber optic networks.
. SONET Services. Full duplex transmission of digital data on Synchronous
Optical Network ("SONET") standards. The Company's local SONET services
allow multipoint transmission of voice, data, or video over protected
fiber optic networks. Available interfaces include DS-1, DS-3, STS-1,
OC-3, OC-12, OC-48, and OC-192.
. Private Network Transport Services. A premium quality, fully redundant,
and diversely routed SONET service that is dedicated to the private use
of individual customers.
. Wavelength or "Lambda" Services. Extremely high capacity, point-to-point
transmission services using DWDM interfaces. Customers have access to
multiple full-bandwidth channels of 2.5 gigabits per second and 10
gigabits per second.
Switched Services
The Company's switched voice services provide business customers with local
calling capabilities and connections to their IXCs. The Company owns, houses,
manages, and maintains the switches used to provide the services. The
Company's switched services include the following:
. Business Access Line Service. This service provides voice and data
customers quality analog voice grade telephone lines for use at any
time. Business access line service provides customers with flexibility
in network configurations because lines can be added, deleted, and moved
as needed.
. Access Trunks. Access trunks provide communication lines between two
switching systems. These trunks are utilized by private branch exchange
customers, which own and operate a switch on their own premises. Private
branch exchange customers use these trunks to provide access to the
local, regional, and long distance telephone networks. Private branch
exchange customers may use either the Company's telephone numbers or
their ILEC-assigned telephone numbers. Customer access to the Company's
local exchange services is accomplished by a DS-1 digital connection or
DS-0 analog trunks between the customer's private branch exchange port
and the Company's switching centers.
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. Local Toll Service. This service provides customers with a competitive
alternative to ILEC service for intraLATA toll calls. It is a
customized, high-quality local calling plan available to the Company's
local exchange service customers.
. Local Telephone Service. Local telephone service can be tailored to a
customer's particular calling requirements. Local telephone service
includes operator and directory assistance services, custom calling
features such as call waiting and caller ID.
. Long Distance Service. Long distance service provides the capabilities
for a customer to place a voice call from one local calling area to
another, including international calling. The long distance offering is
comprised of a full suite of basic long distance services, including
toll-free 800 number service, calling card, and international calling.
The Company offers long distance services bundled with other Company
services because it believes small- and medium-sized businesses may
prefer to obtain long distance, local, and Internet services from a
single provider instead of working with multiple carriers. The Company
also offers usage-based rates for 1+ and toll-free service as well as
package plans for various committed levels of usage. The target
customers are small- and medium-sized business customers. Generally,
large businesses tend to obtain their long distance services directly
from the major long distance carriers.
. Switched Access Service. The connection between a long distance
carrier's POP and an end user's premises that is provided through the
switching facilities of a LEC is referred to as switched access service.
Switched access service provides IXCs with a switched connection to
their customers for the origination and termination of long distance
telephone calls or provides large end users with dedicated access to
their IXC of choice.
. Other Services. The Company also provides bundled solutions to small- to
medium-sized business users. These solutions provide DS-0 (64 Kbps)
channels to which a customer's voice and Internet services can be
connected for integration to a single DS-1 (1.544 Mbps) transport
facility. Many customers purchase voice (local and long distance) on
separate DS-1 or DS-0 facilities. These customers will often have one
vendor for their local service and a different vendor for their long
distance. Additionally, such customers might also purchase Internet
services from yet another vendor on a variety of DS-0 or DS-1
facilities. Such an arrangement results in having three different
vendors and producing at least three different monthly bills. The
Company's bundled offerings enable customers to purchase a single DS-1
transport facility over which lines, trunks, long distance, and Internet
services can be combined to provide an integrated service offering.
Other services offered by the Company include telephone numbers,
listings, customized calling features, voice messaging, hunting,
blocking services, and two-way, simultaneous voice and data transmission
in digital formats over the same transmission line, which is an
international standard referred to as integrated services digital
network or "ISDN."
Data Transmission Services
The Company offers its customers a broad array of data transmission
services that enable customers to create their own internal computer networks
and access external computer networks and the Internet.
In 2001, the Company extended its current base of transparent LAN services
to include a point-to-point Native Local Area Network ("NLAN") service to
customers. NLAN services allow customers to link multiple locations together
over dedicated lines via the Company's high-speed Ethernet interfaces. This
extended bandwidth capacity allows customers to connect at very high speeds to
the Internet, to the application service provider of choice, or to other
customer locations.
The Company also offers unmanaged point-to-point NLAN service. This service
deploys competitive, low cost, 100 Mbps and 1000 Mbps Ethernet connections.
The service is referred to as "unmanaged" because the fiber between customer
locations is entirely dedicated to that customer and is not monitored by the
Company's
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network operations center. Troubleshooting and maintenance of unmanaged NLAN
circuits requires a service visit by a Company technician.
In 2002, the Company plans to introduce a Managed Fibre Channel Transport
Solution. This service will allow customers to transport data to an off-site
storage facility for back up, mirroring, and disaster recovery purposes.
Internet Services
The Company offers high-speed dedicated Internet access to its business
customers. Dedicated service allows the customer to maintain a permanent,
"always on" connection to the Internet and eliminates the need for slower,
less reliable dial-up modems. The Company upgraded its IP backbone in 2001
from ATM (asynchronous transfer mode) to Packet over SONET ("PoS") technology.
As a result of this upgrade, the network is faster, more efficient and more
reliable. It also offers the Company's customers extremely high levels of
availability and performance.
The Company began to offer dedicated web hosting services in late 2000.
Customers are able to use the dedicated servers owned and operated by the
Company for e-mail, web-site hosting, and file transfer. The Company offers
this service in all of its markets primarily as a value add-on for its data
and Internet services customers.
Limitation on Residential and Content Services
The Company's Restated Certificate of Incorporation prohibits the Company
from (i) engaging in the business of providing, offering, packaging,
marketing, promoting, or branding (alone or jointly with or as an agent for
other parties) any residential services, or (ii) producing or otherwise
providing entertainment, information, or other content services, without the
consent of all the Class B Stockholders. This prohibition expires in May 2004,
or earlier if the Class B Stockholders no longer hold 50% of the total voting
power for the Board of Directors, but a similar restriction in the fiber
license agreements with Time Warner Cable continues until 2028. See "Certain
Relationships and Related Transactions". Although management does not believe
that these restrictions will materially affect the Company's business and
operations in the immediate future, the Company cannot predict the effect of
such restrictions in the rapidly changing telecommunications industry.
Telecommunications Networks and Facilities
Overview. The Company uses advanced technologies and network architectures
to develop a highly reliable infrastructure for delivering high-speed, quality
digital transmissions of voice, data, and video telecommunications services.
The Company's basic transmission platform consists primarily of optical fiber
equipped with high-capacity SONET and DWDM equipment deployed in fully
redundant, self-healing rings. These SONET and DWDM rings give the Company the
capability of routing customer traffic in both directions around the ring,
thereby eliminating loss of service in the event of a fiber cut. The Company
has also deployed a next generation Internet backbone using redundant core
routers to deliver Internet traffic to its customers. The Company's networks
contain softswitches to enable enhanced voice services. The Company's networks
are also designed for remote automated provisioning, allowing the Company to
meet customers' real time service needs. The Company extends SONET rings or
point-to-point links from rings to each customer's premises over its own fiber
optic cable and tail circuits obtained from ILECs. The Company also installs
diverse building entry points where a customer's security needs require such
redundancy. The Company then places necessary customer-dedicated or shared
electronic equipment at a location near or in the customer's premises to
terminate the link.
The Company serves its customers from one or more central offices or hubs
strategically positioned throughout its networks. The central offices house
the transmission, switching, and Internet equipment needed to interconnect
customers with each other, the long distance carriers, and other local
exchange networks. Redundant electronics and power supplies, with automatic
switching to the backup equipment in the event of failure, protects
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against signal deterioration or outages. The Company continuously monitors
system components from its network operations centers and proactively focuses
on avoiding problems rather than merely reacting to trouble.
The Company adds switched, dedicated, and data services to its basic fiber
optic transmission platform by installing sophisticated softswitches and
digital electronics at its central offices and nodes at customer locations.
The Company's advanced digital telephone and IP switches are connected to
multiple ILECs and long distance carrier switches to provide the Company's
customers access to telephones in the local market as well as the public
switched telephone network. The Company also provides routers for its Internet
backbone and LAN multiplexers at its customers' premises and in its central
offices to provide high-speed LAN interconnection services.
The Company's strategy for adding customers is designed to maximize the
speed and impact of its marketing efforts while maintaining attractive rates
of return on capital invested to connect customers directly to its networks.
To serve a new customer initially, the Company may use various transitional
links, such as reselling a portion of an ILEC's network. Once the new
customer's communications volume and product needs are identified, the Company
may build its own fiber optic connection between the customer's premises and
the Company's network to accommodate the customer's needs and maximize the
Company's return on network investment.
Telecommunications Networks. The following chart sets forth information
regarding each of the Company's telecommunications networks as of December 31,
2001:
Switched
Network Services
Commercially Commercially
Metropolitan Service Area Available Available(1)
- ------------------------- ------------ ------------
Albany, New York (2).................................. Jul-95 Sep-99
Albuquerque, New Mexico (3)........................... Jan-01 Jan-01
Atlanta, Georgia...................................... Oct-01 Oct-01
Austin, Texas (2)..................................... Sep-94 Apr-97
Bakersfield, California (3)........................... Jan-01 Jan-01
Binghamton, New York (2).............................. Jan-95 Aug-00
Boise, Idaho (3)...................................... Jan-01 Jan-01
Charlotte, North Carolina (2)......................... Sep-94 Dec-97
Chicago, Illinois..................................... Mar-01 --
Cincinnati, Ohio (2).................................. Jul-95 Nov-97
Columbia, South Carolina (2).......................... Jun-01 Jul-01
Columbus, Ohio (2).................................... Mar-91 Jul-97
Dallas, Texas......................................... Sep-99 Sep-99
Dayton, Ohio (2)...................................... Nov-00 Nov-00
Denver, Colorado...................................... Aug-01 Nov-01
Fayetteville, North Carolina (2)...................... Apr-00 Apr-00
Fresno, California (3)................................ Jan-01 Jan-01
Greensboro, North Carolina (2)........................ Jan-96 Sep-99
Honolulu, Hawaii (2).................................. Jun-94 Jan-98
Houston, Texas (2).................................... Jan-96 Sep-97
Indianapolis, Indiana (2)............................. Sep-87 Dec-97
Jersey City, New Jersey............................... Jul-99 Jul-99
Los Angeles, California (3)(4)........................ Jan-01 Jan-01
Manhattan, New York (2)............................... Feb-96 Feb-98
Memphis, Tennessee (2)................................ May-95 May-97
Milwaukee, Wisconsin (2).............................. Feb-96 Sep-97
Minneapolis, Minnesota (2)............................ Jun-01 Nov-01
Oakland, California (3)(5)............................ Jan-01 Jan-01
Orange County, California............................. Dec-00 Dec-00
Orlando, Florida (2).................................. Jul-95 Jul-97
8
Switched
Network Services
Commercially Commercially
Metropolitan Service Area Available Available(1)
- ------------------------- ------------ ------------
Phoenix, Arizona (3).................................. Jan-01 Jan-01
Portland, Oregon (3).................................. Jan-01 Jan-01
Raleigh, North Carolina (2)........................... Oct-94 Sep-97
Rochester, New York (2)............................... Dec-94 Feb-95
Sacramento, California (3)............................ Jan-01 --
San Antonio, Texas (2)................................ May-93 Nov-97
San Diego, California (2)............................. Jun-95 Jul-97
San Francisco, California (3)......................... Jan-01 Jan-01
San Luis Obispo, California (3)....................... Jan-01 Jan-01
Santa Barbara, California (3)......................... Jan-01 Jan-01
Seattle, Washington (3)............................... Jan-01 Jan-01
Spokane, Washington (3)............................... Jan-01 Jan-01
Tampa, Florida (2).................................... Dec-97 Jan-98
Tucson, Arizona (3)................................... Jan-01 Jan-01
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(1) Date of "Switched Services Commercially Available" is the first date on
which switched services were provided to a customer for markets not
acquired from GST.
(2) Metropolitan statistical areas in which the Company obtains or expects to
obtain fiber capacity through licensing agreements with Time Warner Cable.
See "Certain Relationships and Related Transactions."
(3) The "available" date represents the date the assets were acquired from
GST.
(4) Includes Los Angeles, Riverside, and Ventura.
(5) Includes Oakland and Stockton metropolitan statistical areas.
Western Regional Network. As part of the GST asset acquisition, the Company
acquired a regional fiber optic backbone network, extending from Seattle to
San Diego that was substantially completed during 2001. The capacity of the
network varies along the route, ranging from 12 to 144 fibers and six to eight
two-inch conduits. This regional network interconnects many of the Company's
service areas in its western region and is used to provide regional long
distance, voice, Internet, data, and video transport services. The Company may
sell fiber and conduit routes not needed for its operations or may exchange
such routes for other fiber and conduit routes. As part of the GST
transaction, the Company assumed certain agreements to provide long-term
rights to dark fiber and conduit to third parties. Dark fiber consists of
fiber strands contained within a fiber optic cable that are not connected to
electronic equipment. A lease of dark fiber rights typically has a term that
approximates the economic life of a fiber optic strand (generally 20 to 30
years). Purchasers and lessees of dark fiber rights usually install their own
electrical and optical transmission equipment. A purchaser of conduit rights
pulls its own fiber through the conduit, which may be either a spare conduit
or one that already contains the Company's fiber. In general, payment for dark
fiber and conduit rights is due at the time of delivery and acceptance of the
fiber or conduit. A substantial portion of the routes subject to these
agreements were completed in 2001 and the third party rights the Company
agreed to grant under these agreements were granted and paid for in 2001. The
Company expects to complete the grant of rights to third parties on the
Ontario to San Diego, California route and to receive the corresponding
payments during the first quarter of 2002.
Network Monitoring and Management. The Company provides a single point of
contact for its customers and consolidates its systems support, expertise, and
technical training for the telephony network at its network operations center
in Greenwood Village, Colorado. With approximately 1,260 technicians and
customer service representatives dedicated to providing superior customer
service, the Company is able to quickly correct, and often anticipate,
problems that may arise in its networks. The Company provides 24 hours-a-day,
7 days-a-week surveillance and monitoring of networks to achieve a high level
of network reliability and performance. Network analysts monitor real-time
alarm, status, and performance information for network circuits, which allows
them to react swiftly to repair network trouble. In order to increase
operating efficiencies and reduce expenses, in late
9
2001 the Company began the consolidation of the network operations center in
Vancouver, Washington acquired through the GST asset acquisition into its
Greenwood Village network operations center. The Company expects the
consolidation to be complete by the end of the first quarter of 2002.
The Company also maintains an Internet network operations center in
Milwaukee, Wisconsin that handles all provisioning, call center, and
surveillance functions for the Company's IP backbone and services, including
Internet access and web hosting, provided over the Company's IP backbone.
Infrastructure Migration. The Company continually evaluates new
technologies and suppliers in order to achieve a balance between utilizing
best of breed technologies and suppliers, and purchasing equipment at the best
available price. IP capabilities are proliferating throughout the network as
is evidenced by the rapid development and deployment of packet telephony
systems (e.g., media gateways and softswitches). In order to prepare to
deliver the next generation voice and data services, the Company is using
softswitch, optical, and data/Internet technologies to augment legacy circuit
switched telephone systems and is deploying these technologies in certain
markets to complement circuit switched systems. The Company plans to offer IP
Centrex, packet telephony, metropolitan LAN, storage, and wavelength services
over this platform in 2002. As an extension of the Signaling System 7 ("SS7")
network that the Company acquired in connection with the GST asset
acquisition, in 2001 the Company launched an initiative to extend the acquired
SS7 network to many of its existing networks. The migration to the Company's
internal SS7 network is expected to be complete during 2002 and is expected to
decrease the Company's dependence on other providers.
Information Systems Infrastructure. The Company uses a centrally deployed
series of client server platforms and relational database servers to provide
cost effective computing support for its business functions. These services
and products enable employees to support customers directly, manage the
telephony infrastructure, and report and manage trouble resolution. The
computing infrastructure strategy enables the Company to mix and match
computing platforms to meet its specific business needs including telephony
ordering, provisioning, inventory, engineering, installation, billing,
decision support, and customer care business functions. The strategy of buying
"off the shelf" products and integrating them into the Company's existing
information systems infrastructure versus utilizing several stand-alone
applications supports a more responsive and flexible environment. The
Company's information systems provide real time support of network operations
and deliver data at the network, regional and corporate level, sorted by
customer and vendor. The systems selected or built utilize open system
standards and architectures, allowing interoperability with third parties'
systems. The Company's information technology teams have developed
competencies in application integration using the latest in enterprise
application products and strategies. The Company has implemented an enterprise
resource system, which provides improved real-time management information for
the Company's financial, procurement, and human resource functions.
Network Development and Application Laboratory. The Company's network
development and application laboratory is a comprehensive telecommunications
technology, applications, and services development laboratory, equipped with
advanced systems and equipment, including those used by the Company in the
operation of its local digital networks. The center is designed to provide a
self-contained testing and integration environment, fully compatible with the
Company's digital networks, for the purposes of:
. verifying the technical and operational integrity of new equipment prior
to installation in the networks;
. developing new services and applications;
. providing a realistic training environment for technicians, engineers,
and others; and
. providing a network simulation environment to assist in fault isolation
and recovery.
Technologies currently under evaluation in the laboratory include DWDM
equipment from new vendors, optical switches, next generation Multi Service
Platform, IP telephony, including components used to service next generation
softswitches, media gateway technologies, application servers, and data and
Internet equipment including edge routers and metropolitan Ethernet switches.
10
Billing Systems. The Company contracts with outside vendors for customer
billing. The Company has licensed a system for transport and switched services
billing that it operates on its own equipment and has a service bureau
arrangement with another vendor for carrier and interconnection billing. In
2001, the Company completed the migration of its billing of acquired accounts
from the platforms inherited from the acquisition of GST assets to the billing
platform that the Company uses for its other markets.
Customers and Sales and Marketing
The Company's customers are principally telecommunications-intensive
medium- and large-sized business end users including financial services,
health care, media and technology companies, long distance carriers, ISPs,
wireless communications companies, ILECs, and various governmental entities.
The Company has substantial business relationships with a few large
customers. For the year ended December 31, 2001, the Company's top ten
customers accounted for approximately 47% of its total revenue. Excluding the
impact of the recognition of $37.0 million in non-recurring reciprocal
compensation revenue, the Company's top ten customers accounted for 44% of
revenue in 2001. The Company's largest customer for the twelve months ended
December 31, 2001, WorldCom Inc. and its affiliates, accounted for 12% of the
Company's total revenue. However, a portion of that revenue results from
traffic that is directed to the Company by customers that have selected
WorldCom Inc. as its long distance carrier. No other customer, including
customers who direct their business through long distance carriers, accounted
for 10% or more of the Company's revenue in 2001. In 2001, the three companies
that individually represented more than 5% of total 2001 revenue, excluding
the impact of the non-recurring reciprocal compensation revenue described
above, were WorldCom Inc., AT&T, and Qwest Communications Inc.
The Company maintains a direct sales effort in each of its service areas
along with regional and national sales support. The number of sales account
executives totaled 288 at December 31, 2001. Compensation for the Company's
sales representatives is based primarily on commissions linked to revenue from
services installed. The Company provides enhanced commissions to its sales
force for executing service contracts with terms of two years or greater and
for services entirely on the Company's network. Currently, more than half of
the Company's revenue from services subject to service agreements is provided
under agreements with an initial duration of three years or greater. In
addition, the Company markets it services through advertisements, trade
journals, media relations, direct mail, and participation in trade
conferences.
The Company also targets long distance carriers, ISPs, ILECs, large
strategic business accounts, and wireless telephone companies through its
national sales organization. The Company has master services agreements with a
significant number of the long distance carriers, including AT&T, WorldCom
Inc., Sprint Corporation, and Qwest Communications Inc. By providing long
distance carriers with a local connection to their customers, the Company
enables them to avoid complete dependence on the ILECs for access to customers
and to obtain a high-quality and reliable local connection. The Company
provides a variety of transport services and arrangements that allow long
distance carriers to connect their own switches in both local areas, or intra-
city, and wide areas, or inter-city. Additionally, long distance carriers may
purchase the Company's transport services that allow them to connect their
switch to an ILEC switch and to end user locations directly. The Company's
networks allow it to offer high volume business customers and long distance
carriers uniformity of services, pricing, quality standards, and customer
service.
In 2001, the demand from carrier customers fell and the Company experienced
significant service disconnections as a result of bankruptcies, customers
contracting their operations, and customers optimizing their existing networks
in response to the economic downturn. As a result, the Company increased its
focus on established carrier customers and on end user customers to replace
the revenue lost to disconnections.
The Company's marketing emphasizes its:
. reliable, facilities-based networks;
11
. flexibly-priced, bundled services;
. responsive customer service orientation; and
. integrated operations, customer support, network monitoring, and
management systems.
The Company's centrally managed customer support operations are designed to
facilitate the processing of orders for changes and upgrades in customer
services. To reduce the risk in bringing new and untested telecommunications
services to a dynamically changing market, the Company introduces its services
once market demand develops, and offers them in diversified, competitively-
priced bundles in order to increase usage among its existing customers and
attract new customers. The services offered by the Company are typically
priced at a discount to the ILECs' prices.
Customer Service
With approximately 1,260 technicians and customer service representatives
at December 31, 2001, the Company provides its customers with continuous
support and superior service. To serve its customers, account representatives
are assigned to the Company's customers to act as effective liaisons with the
Company. Technicians and other support personnel are available in each of the
Company's service areas to react to any network failures or problems. In
addition, the network operations center provides 24 hours-a-day, 7 days-a-week
surveillance and monitoring of networks to maintain the Company's network
reliability and performance. See "Telecommunications Networks and Facilities--
Network Monitoring and Management."
Competition
The Company believes that the principal competitive factors affecting its
business are and will continue to be:
. pricing;
. competition for skilled, experienced personnel;
. regulatory decisions and policies that impact competition;
. ability to introduce new services; and
. the availability of proven support systems for the Company's back office
systems, including provisioning and billing.
The Company believes that it competes favorably with other companies in the
industry or is generally impacted favorably with respect to each of these
factors. The technologies and systems that provide back office support for the
competitive local exchange carrier ("CLEC") industry are nascent and may not
keep pace with the growth of order volume, integration with other systems, and
production of required information for systems managers. Although the
Company's ability to attract qualified personnel improved in 2001 as a result
of contraction of the CLEC industry and the economy in general, personnel with
certain types of technical expertise are still in demand and the Company must
compete with other employers by maintaining competitive compensation and
benefits packages, in addition to an attractive work environment. Regulatory
environments at both the state and federal level differ widely and have
considerable influence on the Company's market and economic opportunities and
resulting investment decisions. The Company believes it must continually
monitor regulatory developments and remain active in its participation in
regulatory issues. Some regulatory decisions have or may in the future have
negative impacts on the Company's revenue or expenses, and may favor certain
classes of competitors over the Company. See "Government Regulation."
Services substantially similar to those offered by the Company are also
offered by the ILECs, Verizon Corporation, BellSouth Corporation, Qwest
Communications Inc., and SBC Communications, Inc. The Company believes that
many ILECs may have competitive advantages over the Company such as their
long-standing
12
relationships with customers, greater technical and financial resources, and
the potential to subsidize services of the type offered by the Company from
service revenue in unrelated businesses. However, the Company believes that
its customers are increasingly interested in alternate providers for
redundancy of networks and enhanced disaster recovery. In light of the
bankruptcies in the CLEC sector, some customers are seeking financially stable
providers to a greater extent than in prior years. In most of the metropolitan
areas in which the Company currently operates, at least one, and sometimes
several other CLECs offer substantially similar services at substantially
similar prices to those of the Company.
With several facilities-based carriers providing the same service in a
given market, price competition is likely and can be severe. As a result, the
Company has experienced price competition that is expected to continue. In
addition, the Company believes that weakness in the CLEC sector has led to
below-cost pricing as certain competitors seek to meet revenue targets without
regard to profit margin. During 2001 and continuing into the first quarter of
2002, due to business failures and contractions, the overall number of
competitors declined, and competitors slowed or stopped their build-out plans.
A number of the Company's CLEC competitors have been undergoing restructuring
either in the context of Chapter 11 bankruptcy proceedings or as a result of
serious liquidity problems. Some of these competitors could emerge from these
restructuring transactions with little or no indebtedness, which could lead to
further downward pricing pressure. In each of its service areas, additional
competitors could build facilities. If additional competitors build facilities
in the Company's service areas, this price competition may increase
significantly.
The Company also faces competition from other CLECs, cable television
companies, electric utilities, long distance carriers, wireless telephone
system operators, and private networks built by large end users that
presently, and may in the future, offer services similar to those offered by
the Company.
The Telecommunications Act of 1996 (the "1996 Act") allows the regional
Bell operating companies ("RBOCs") and others, such as electric utilities, to
enter the long distance market. Certain of the RBOCs have begun providing out-
of-region long distance services. When a RBOC obtains authority to provide in-
region interLATA services, it will be able to offer customers both local and
long distance telephone services. Given the market power the RBOCs currently
possess in the local exchange market, the ability to provide both local and
long distance services is expected to make the RBOCs very strong competitors.
To date, two Bell operating companies--Verizon Corporation in New York,
Massachusetts, Rhode Island, Pennsylvania, and Connecticut and Southwestern
Bell Telephone Company in Texas, Kansas, Oklahoma, Arkansas and Missouri--have
been granted authority under Section 271 to provide in-region interLATA
service. Verizon Corporation has also applied to the Federal Communications
Commission ("FCC") for Section 271 authority in New Jersey. It is expected
that the RBOCs will submit additional applications for Section 271 authority
to the FCC in the future.
Additional competition may arise from long haul and calling card service
providers that are attempting to enter the IP telephony market. The Company
cannot predict whether those companies will be successful or whether they will
provide significant competition for the Company's services. At this time, the
FCC has not yet determined whether to subject IP telephony to the same
regulatory requirements applicable to traditional telecommunications services,
including, for example, the obligation to support universal service and the
requirement to pay access charges to LECs.
The Company believes that certain IXCs are pursuing alternatives to their
current practices with regard to obtaining local telecommunications services,
including acquisition or construction of their own facilities. In addition,
IXCs may be able to provide local service by reselling the facilities or
services of an ILEC or the services of another CLEC, which may be more cost
effective for an IXC than using the Company's services.
To the extent the Company interconnects with and uses ILEC networks to
service its customers, the Company depends on the technology and capabilities
of the ILECs to meet certain telecommunications needs of the Company's
customers and to maintain its service standards. The Company also uses ILEC
special access services to reach certain buildings that are not served by the
Company's network. Although the 1996 Act imposes interconnection obligations
on ILECs, the regulation of ILEC performance standards and the imposition of
non-
13
performance remedies is still developing and there is no assurance that the
Company will be able to obtain all of the ILEC services it needs on a timely
basis or that the quality of service it receives will be acceptable. In the
event that the Company experiences difficulties in obtaining high-quality,
reliable, and reasonably priced service from the ILECs, the attractiveness of
the Company's services to its customers could be impaired.
Government Regulation
Historically, interstate and foreign communication services were subject to
the regulatory jurisdiction of the FCC, and intrastate and local
telecommunications services were subject to regulation by state public service
commissions. With enactment of the 1996 Act, competition in all
telecommunications market segments, including local, toll, and long distance,
became matters of national policy. The Company believes that the national
policy fostered by the 1996 Act has contributed to significant market
opportunities for the Company. As federal and state regulatory commissions
have largely implemented the provisions of the 1996 Act, the Company believes
that future regulation will focus largely on enforcement of carrier-to-carrier
requirements under the law and on consumer protection measures.
Telecommunications Act of 1996. The 1996 Act is intended to increase
competition in local telecommunications services by requiring ILECs to
interconnect their networks with CLECs. The 1996 Act imposes a number of
access and interconnection requirements on all LECs, including CLECs, with
additional requirements imposed on ILECs. Under the 1996 Act, ILECs are
required to attempt to negotiate with CLECs wanting to interconnect with their
networks. The Company has successfully negotiated interconnection agreements
with the ILECs in each of the markets in which it offers switched services and
has negotiated, or is negotiating, secondary interconnection arrangements with
carriers whose territories are adjacent to the Company's for intrastate
intraLATA toll traffic and extended area services. To the extent agreements
have expired, the Company has either renegotiated or is in the process of
negotiating new contracts. Typically, expired agreements allow the Company to
continue to exchange traffic with the other carrier pending execution of a new
agreement. Currently, a few ILECs are seeking renegotiation of certain terms
and conditions, including reciprocal compensation for ISP-bound traffic. The
Company cannot predict the outcome of such negotiations, especially in light
of pending legal and regulatory actions pertaining to reciprocal compensation,
as described below.
In August 1996, the FCC promulgated rules to govern interconnection,
resale, unbundled network elements, and the pricing of those facilities and
services, as well as rules to govern, among other things, the dialing parity
requirements of the 1996 Act. Although certain ILECs and states challenged the
authority of the FCC to issue these rules, on review, the Supreme Court upheld
most of the FCC's rules and confirmed the FCC's authority to issue national
pricing rules. The Supreme Court did not, however, address the lawfulness of
the specific pricing rules established by the FCC. In July 2000, this issue
was addressed when the 8th Circuit Court of Appeals found the Total Element
Long Run Incremental Cost ("TELRIC") standard to be unlawful and vacated
certain aspects of the rules. The pricing issue is now pending before the
Supreme Court. Elimination of the TELRIC pricing standard could increase costs
to the Company of interconnection and related services from ILECs.
Reciprocal compensation revenue is an element of switched services revenue
which represents compensation from LECs for local exchange traffic terminated
on the Company's facilities originated by other LECs. Historically, a portion
of the reciprocal compensation revenue payable to the Company, like other
CLECs, has resulted from the termination of calls to the Company's ISP
customers. As dial-up Internet traffic has grown, ILECs have challenged the
requirement to pay reciprocal compensation for ISP-bound traffic under various
legal theories. In June 2001, the FCC reaffirmed its jurisdiction over dial-up
Internet-bound traffic, and adopted an interim carrier-to-carrier cost
recovery scheme for such traffic. The new regulatory scheme phases in
reductions on the maximum compensation rate for dial-up Internet-bound traffic
over a three-year period. The FCC initiated a rulemaking to consider whether
it should replace all existing intercarrier compensation schemes with some
form of "bill and keep". "Bill and keep" means that neither carrier receives
compensation for Internet-bound traffic. The FCC has completed an initial
comment cycle, but there has been no further activity on this proceeding to
date. The interim carrier-to-carrier cost recovery rule will have a negative
impact on the Company's revenue
14
stream. The new regulatory construct also imposes bill and keep payment
arrangements for Internet-bound traffic as carriers enter new markets. As a
result of the FCC's order, state commissions lack authority over Internet-
bound traffic compensation issues, except that state commission decisions
regarding this traffic for prior periods were not affected by the order. The
Company and several other CLECs filed legal challenges to the FCC's order in
federal court. There is no assurance, however, that any legal challenge will
be successful or that a successful challenge will change the trend toward
reduced reciprocal compensation. In some cases the Company's right to receive
reciprocal compensation for traffic terminated to its ISP customers was
contractually dependent on the outcome of regulatory proceedings addressing
reciprocal compensation for ISP traffic. The impact of the FCC's 2001 ruling
on the payment of reciprocal compensation under some of those agreements is
still in dispute with certain ILECs. The rate reductions resulting from the
FCC order and exclusion of ISP-bound traffic from reciprocal compensation
requirements in new markets will reduce the revenue received by the Company
for terminating traffic originated by ILECs. The adoption of a bill and keep
regime for all existing intercarrier compensation schemes would further reduce
the Company's revenue, and to a much lesser extent, its expenses.
Federal Regulation. Switched access is the connection between a long
distance carrier's point of presence and an end user's premises provided
through the switching facilities of a LEC. Historically, the FCC has regulated
the access rates imposed by the ILECs while the CLEC access rates have been
less regulated. In May 2000, the FCC ordered a substantial reduction in ILEC
per-minute access charges and an increase in the flat monthly charge paid by
local residential service subscribers for access to interstate long distance
service. The FCC also released an order effective in June 2001 that subjects
CLECs' interstate switched access charges to regulation. Effective with that
order, the Company's rates were reduced and will continue to decline over a
three-year period to parity with the ILEC rates competing in each area. In
addition, when a CLEC enters a new market its access charges may be no higher
than the ILEC's. This order does not affect rates subject to contracts that
the Company has entered into with certain long distance carriers. The Company
and several other CLECs have filed petitions with the FCC for reconsideration
of the provisions of the order relating to new markets, and other carriers
have challenged the order in federal court. There is no assurance that any
legal challenge will be successful or that a successful challenge will change
the trend toward lower access charges. The ILEC access reform decision, as
well as the CLEC access charge regulation have resulted in reductions in the
per-minute rates the Company receives for switched access service in 2001 and
will likely result in further reductions. There is no assurance that the
Company will be able to compensate for reductions in switched access revenue
resulting from the FCC order with revenue from other sources.
In addition, federal legislation entitled "Internet Freedom and Broadband
Deployment Act of 2001" has passed the U.S. House of Representatives and is
pending before the Senate. This legislation, commonly referred to as HR 1542,
or the Tauzin-Dingell Bill, is designed to prohibit the FCC and each state
from regulating high-speed data services. The Company believes that this
legislation harms telecommunications competition by removing existing
regulation that protects consumers and carriers from monopoly abuses. If
passed, the Company believes HR 1542 could have an adverse impact on the
Company's strategy. The Company cannot predict whether the legislation will
become law in 2002 or ever.
In a February 1999 order, the FCC allowed for increases to commingled cable
and telephony pole attachment rates beginning in February 2001. While there
was no significant impact to the Company in 2001, this order could result in
future increases to the Company's costs associated with pole attachments.
State Regulation. The Company has obtained all state government authority
needed to conduct its business as currently contemplated. Most state public
service commissions require carriers that wish to provide local and other
jurisdictionally intrastate common carrier services to be authorized to
provide such services. The Company's operating subsidiaries and affiliates are
authorized as common carriers in 24 states. These certifications cover the
provision of switched services including local basic exchange service, point-
to-point private line, competitive access services, and long distance
services.
Local Government Authorizations. The Company may be required to obtain from
municipal authorities street opening and construction permits and other
rights-of-way to install and expand its networks in certain
15
cities. In some cities, the Company's affiliates or subcontractors already
possess the requisite authorizations to construct or expand the Company's
networks. Any increase in the difficulty or cost of obtaining these
authorizations and permits could adversely affect the Company, particularly
where it must compete with companies that already have the necessary permits.
In some of the metropolitan areas where the Company provides network
services, the Company pays right-of-way or franchise fees based on a percent
of gross revenue or other metrics such as access lines. However,
municipalities that do not currently impose fees may seek to impose fees in
the future, and following the expiration of existing franchises, fees may be
increased. Under the 1996 Act, municipalities are required to impose such fees
on a competitively neutral and nondiscriminatory basis. However,
municipalities that currently favor the ILECs may or may not conform their
practices in a timely manner or without legal challenges by the Company or
another competitive access provider or CLEC. Moreover, ILECs with whom the
Company competes may be excluded from such local franchise fee requirements by
previously-enacted legislation allowing them to utilize rights-of-way
throughout their states without being required to pay franchise fees to local
governments.
If any of the Company's existing franchise or license agreements for a
particular metropolitan area were terminated prior to its expiration date and
the Company were forced to remove its fiber optic cables from the streets or
abandon its network in place, even with compensation, such termination could
have a material adverse effect on the Company's operation in that metropolitan
area and could have a material adverse effect on the Company.
The Company is party to various regulatory and administrative proceedings;
however, subject to the discussion above, the Company does not believe that
any such proceedings will have a material adverse effect on its business.
Employees
As of December 31, 2001, the Company had 2,661 employees. The Company is
eliminating approximately 200 positions primarily in its Vancouver, Washington
operations in a consolidation of its network operations centers that is
expected to be completed by the end of the first quarter of 2002. The Company
believes that its relations with its employees are good. By succession to
certain operations of Time Warner Cable, the Company's operation in New York
City is a party to a collective bargaining agreement. In connection with the
construction and maintenance of its networks and the conduct of its other
business operations, the Company uses third party contractors, some of whose
employees may be represented by unions or collective bargaining agreements.
The Company believes that its success will depend in part on its ability to
attract and retain highly qualified employees and maintain good working
relations with its current employees.
Risk Factors
Some of our customer agreements may not continue and customers may continue
to disconnect services.
Some of our customer agreements are subject to termination on short notice
and do not require the customer to maintain its agreements at current levels.
We cannot assure that such customers will continue to purchase the same
services or level of services. In fact, we have experienced significant
service disconnections in 2001 due to customer bankruptcies, customers
contracting their operations and customers optimizing their existing networks
in response to the economic downturn. In addition, we believe that certain
IXCs are pursuing alternatives to their current practices with regard to
obtaining local telecommunications services, including acquisition or
construction of their own facilities. Although the Company was successful in
replacing revenue lost in 2001 to disconnections or other customer
difficulties, there is no assurance that the Company will continue to be able
to do so.
During 2001, a number of our customers filed bankruptcy proceedings. In
connection with those proceedings, the customers may choose to assume or
reject their contracts with us. If they choose to reject those
16
contracts, our only recourse is an unsecured claim for rejection damages that
is likely to result in little or no compensation to us for the lost revenue.
As of December 31, 2001, less than 4% of the Company's monthly revenue was
represented by customers that had filed bankruptcy proceedings and that could
reject or otherwise terminate their agreements with the Company. Since
December 31, 2001, additional customers filed bankruptcy proceedings bringing
the total percentage of monthly revenue from customers in bankruptcy to
approximately 5%. Customer bankruptcies are likely to continue until the
economy improves, and there is no assurance that the Company will not continue
to lose significant recurring revenue due to customer bankruptcies.
Our acquisition of the GST assets increased our leverage and poses other
risks.
Our acquisition of the GST assets is considerably larger than the
transactions we have completed in the past. Although we have completed the
first phase of the integration of these assets into our business--integrating
the sales, marketing, and operations--the integration of our back office
systems is not expected to be completed until the end of 2002. In 2001, our
gross margins from the acquired operations were worse than the margins for our
core business (meaning the historic regions and operations of the Company,
including the five new markets activated in 2001).
Although the Company believes it is in a position in 2002 to improve those
margins, potential risks include the inability of the Company to grow revenue
from the acquired assets, the inability of the Company to achieve operating
efficiencies, the possible difficulty of managing our growth and information
systems, and the possibility that the liabilities we assumed to complete
performance under GST contracts may prove to be greater than anticipated.
We may have difficulty achieving the benefits intended from the acquisition
of the GST assets.
We purchased substantially all of the assets of GST with the expectation
that the asset purchase would result in certain benefits, including expansion
of the markets we serve and increasing our operational efficiencies. Achieving
the benefits of the asset purchase will depend upon the successful integration
of the acquired businesses into our existing operations, much of which has
already occurred, and our ability to generate substantial additional revenue
from those assets. We cannot assure that we will be successful in achieving
the anticipated benefits of the acquired GST assets. The risks associated with
the acquisition include but are not limited to:
. the diversion of our management's attention, as integrating the GST
operations and assets has required and will continue to require a
substantial amount of management time;
. difficulties associated in assimilating GST's information systems;
. the inability to generate substantial revenue from the regional network
assets, which will require significant expense to maintain.
The Company cannot assure that it will be able to successfully overcome the
risks associated with integrating the assets it acquired from GST and
generating sufficient additional revenue at attractive margins.
We will require substantial capital to expand our operations.
The development and expansion of our networks requires substantial capital
investment. If this capital is not available when needed, our business will be
adversely affected. The Company expects its 2002 capital expenditures to be
less than the 2001 total of $425 million. We expect our principal capital
requirements for 2002 to be for additional building entries and distribution
rings needed to reach additional customers, and upgrades to our management
information and back office systems. We also expect to have substantial
capital expenditures in subsequent periods.
In December 2000, we executed agreements replacing our $475 million senior
secured credit facility with a $1 billion amended and restated senior secured
credit facility, and in January 2001 completed an offering of $400
17
million principal amount of 10 1/8% Senior Notes. The acquisition of the GST
assets was initially financed in January 2001 with borrowings under an
unsecured bridge loan facility that was repaid in full with $532 million in
net proceeds from the Company's offering of Class A common stock in January
2001 and a portion of the net proceeds from the sale of the 10 1/8% Senior
Notes. As of December 31, 2001, we have drawn $250 million of the $1 billion
senior secured credit facility. We may be required to seek additional
financing if:
. our business plans and cost estimates prove to be inaccurate;
. we decide to accelerate the expansion of our business and existing
networks;
. we consummate further acquisitions or joint ventures that require
capital; or
. we are not able to generate sufficient cash flow from operations.
If we were to seek additional financing, the terms offered may place
significant limits on our financial and operating flexibility, or may not be
acceptable to us. The failure to raise sufficient funds if needed and on
reasonable terms may require us to modify or significantly curtail our
business plan. This could have a material adverse impact on our growth,
ability to compete, and ability to service our existing debt.
The Company's senior secured credit facility and the indentures for the 9
3/4% Senior Notes and the 10 1/8% Senior Notes contain restrictive covenants
that may limit our flexibility.
The senior secured credit facility and indentures limit, and in some
circumstances prohibit, our ability to:
. incur additional debt;
. pay dividends;
. make investments or other restricted payments;
. engage in transactions with stockholders and affiliates;
. create liens;
. sell assets;
. issue or sell capital stock of subsidiaries; and
. engage in mergers and acquisitions.
These covenants may limit our financial and operating flexibility. In
addition, if we do not comply with these covenants and financial covenants in
the senior secured credit facility that require the Company to maintain
certain minimum financial ratios, the lenders under the senior secured credit
facility and the holders of the 9 3/4% and 10 1/8% Senior Notes may accelerate
repayment of our debt. The financial ratios include interest coverage,
leverage, senior leverage, and debt service coverage ratios. See Item 7.
Management's Discussion and Analysis of Financial Conditions and Results of
Operations--Liquidity and Capital Resources for a description of these ratios.
In addition, the lenders under the senior secured credit facility could refuse
to lend additional funds if we are not in compliance. The Company could be in
non-compliance with financial covenants in the future due to factors beyond
its control such as losses of revenue or reduction in margins or impairment of
its assets.
Our substantial indebtedness, and servicing our indebtedness, may impair our
financial and operating flexibility.
As of December 31, 2001, we had approximately $1.1 billion of consolidated
total long-term debt. This substantial indebtedness may have an adverse impact
on us. For example:
. our ability to obtain additional financing may be limited;
. a substantial portion of our cash flow will be dedicated to pay interest
and principal on our debt;
18
. our ability to satisfy our debt obligations may be diminished;
. we may be more vulnerable to economic downturns; and
. our ability to withstand competitive pressure may decrease.
The Company may be required to record an impairment charge in the future.
Under generally accepted accounting principles, the Company is required to
review the carrying amounts of its assets to determine whether current events
or circumstances warrant adjustments to those amounts. These determinations
are based in part on management's judgments regarding the cash flow potential
of various assets, and involve projections that are inherently subject to
change based on future events. If management concludes in the future that the
cash flow potential of any of its assets is significantly less than it
believed at the time of purchase, and that conclusion is based on a long-term
rather than short-term trend, the Company may need to record an impairment
charge. Although the Company does not believe that any of its assets are
currently impaired, that judgment could change based on changed circumstances.
An impairment charge would have a negative impact on the Company's earnings.
To service our indebtedness, we will require a significant amount of cash,
and our ability to generate cash depends on many factors beyond our control.
Our ability to make payments on our indebtedness and to fund planned
capital expenditures will depend on our ability to generate cash in the
future.
Our historical financial results have been, and our future financial
results might be, subject to substantial fluctuations. We cannot assure that
our business will generate sufficient cash flow from operations, that
currently anticipated cost savings and operating improvements will be realized
on schedule, or that future borrowings will be available to us in an amount
sufficient to enable us to pay our indebtedness or fund our other liquidity
needs. These uncertainties are exacerbated by the current economic downturn.
If we are unable to pay our debts, we will be required to pursue one or more
alternative strategies, such as selling assets, refinancing or restructuring
our indebtedness, or selling equity capital. However, we cannot assure that
any alternative strategies will be feasible at the time due to market
conditions or other factors, or that such strategies would prove adequate.
Also, certain alternative strategies will require prior consent of our debt
holders.
Our business may be adversely affected if we do not successfully manage the
expansion of our new markets and services.
We plan to offer new communications services, expand service in our
existing markets, and interconnect our existing markets. If we are not
successful in implementing these changes on-time and on-budget, our results of
operations will likely be adversely affected.
Our ability to manage this expansion depends on many factors, including the
ability to:
. attract new customers and sell new services to existing customers;
. design, acquire, and install transmission and switching facilities;
. employ new technologies;
. obtain any required governmental permits and rights-of-way;
. implement interconnection with ILECs;
. train and manage our employee base;
. enhance our financial, operating, and information systems to effectively
manage our growth; and
. accurately predict and manage the cost and timing of our capital
expenditure programs.
19
Even if we are successful in completing the infrastructure to support our
expanded business, that business may not be profitable and may not generate
positive cash flow for us.
Several customers account for a significant portion of our revenue.
We have substantial business relationships with a few large customers. For
the year ended December 31, 2001, our top ten customers accounted for
approximately 47% of our total revenue. Excluding the impact of the
recognition of $37.0 million in non-recurring reciprocal compensation revenue,
our top ten customers accounted for 44% of revenue in 2001. Our largest
customer for the year ended December 31, 2001, WorldCom Inc. and its
affiliates, accounted for 12% of our total revenue. However, a portion of that
revenue results from traffic that is directed to us by customers that have
selected WorldCom Inc. as their long distance carrier. No other customer,
including customers who direct their business through long distance carriers,
accounted for 10% or more of revenue in 2001. In 2001, the four companies that
individually represented more than 5% of total revenue, were WorldCom Inc.,
AT&T Corp., SBC Communications Inc., and Qwest Communications Inc. However,
excluding the impact of non-recurring reciprocal compensation, revenue from
SBC Communications Inc. represented less than 5% of total 2001 revenue.
We are dependent on Time Warner Cable's permits, licenses, and rights-of-way.
We currently license a significant portion of our fiber optic capacity from
Time Warner Cable. Municipalities that regulate Time Warner Cable may or may
not seek to impose additional franchise fees or otherwise charge Time Warner
Cable for the capacity we license. We must reimburse Time Warner Cable for any
new fees or increases in existing fees. Time Warner Cable or the Company may
not be able to obtain all necessary permits, licenses, or agreements from
governmental authorities or private rights-of-way providers necessary to
effect future license transactions. This would hinder our ability to expand
our existing networks or develop new networks successfully in locations served
by Time Warner Cable.
Our quarterly operating results will fluctuate.
As a result of the limited revenue and significant expenses associated with
the expansion and development of our networks and services, we anticipate that
our operating results could vary significantly from quarter to quarter.
Changes in the usage or payment patterns of significant customers and customer
bankruptcies may also cause operating results to vary.
We depend on third party vendors for information systems.
We have entered into agreements with vendors that provide for the
development and operation of back office systems, such as ordering,
provisioning, and billing systems. The failure of those vendors to perform
their services in a timely and effective manner at acceptable costs could have
a material adverse effect on our growth and our ability to monitor costs, bill
customers, provision customer orders, and achieve operating efficiencies.
If we do not adapt to rapid changes in the telecommunications industry, we
could lose customers or market share.
The telecommunications industry has experienced, and is expected to
continue to experience, rapid and significant changes in technology. While we
believe that, for the foreseeable future, these changes will neither
materially affect the continued use of fiber optic cable or digital switches
and transmission equipment, nor materially hinder our ability to acquire
necessary technologies, we cannot predict the effect of technological changes
on the Company's business and operations. We believe that our future success
will depend, in part, on our ability to anticipate or adapt to these changes
and to offer, on a timely basis, services that meet customer demands on a
competitive basis. There can be no assurance that we will obtain access to new
technologies on a timely basis or on satisfactory terms. Our failure to obtain
new technologies could have a material adverse impact on our business,
financial condition, and results of operations.
20
We are controlled by the Class B Stockholders.
Subsidiaries of AOL Time Warner Inc. and affiliates of Advance/Newhouse
Partnership, the Class B Stockholders, hold all the outstanding shares of the
Company's Class B common stock. At February 28, 2002, the AOL Time Warner
stockholder group holds 71.1% of the Company's voting power and 43.9% of its
outstanding common stock. The Advance/Newhouse stockholder group holds 22.0%
of the Company's voting power and 13.6% of its outstanding common stock. The
Class B Stockholders generally have the collective ability to control all
matters requiring stockholder approval, including the nomination and election
of directors. The Class B common stock is not subject to any mandatory
conversion provisions other than pursuant to certain transfer restrictions.
The disproportionate voting rights of the Class B common stock relative to the
Class A common stock may delay or prevent a change in control of the Company,
and may make us a less attractive takeover target.
Our Board of Directors consists of nine director positions. We currently
have one vacancy due to the resignation in November 2001 of William Schleyer,
an independent director. Under the Stockholders' Agreement, the AOL Time
Warner stockholder group has the right to designate four nominees for the
Board of Directors and the Advance/Newhouse stockholder group has the right to
designate one nominee. Under the Stockholders' Agreement, Class B Stockholders
agree to vote in favor of all nominees selected by the Class B Stockholders.
Class B Stockholders will also have the power to elect the other members of
our Board of Directors.
Each of the Class B Stockholders has veto rights over certain actions.
Under our Restated Certificate of Incorporation, as long as the outstanding
Class B common stock represents at least 50% of the aggregate voting power of
both classes of common stock outstanding, the approval of 100% of the Class B
Stockholders is required:
. to permit us to provide residential services or content services prior
to May 2004;
. to amend our Restated Certificate of Incorporation, other than in
connection with certain ministerial actions; or
. for any direct or indirect disposition by us of capital stock of
subsidiaries or assets that in either case represents substantially all
our assets on a consolidated basis.
The approval of 100% of the Class B Stockholders is also required for the
issuance of any additional shares of Class B common stock or any capital stock
having more than one vote per share.
The holders of Class B common stock can sell control of the Company at a time
when they do not have a majority economic interest in the Company, and
exclude the holders of Class A common stock from participating in the sale.
The Stockholders' Agreement provides that, subject to the rights of first
refusal of the other holders of Class B common stock, the Class B Stockholders
may transfer their Class B common stock. If a holder sells all, but not less
than all, of its Class B common stock as shares of Class B common stock, such
holder may transfer its right to nominate Class B nominees for election to the
Board of Directors. In addition, all of the holders of Class B common stock
have the right to participate in certain sales by the AOL Time Warner
stockholder group of its Class B common stock. Accordingly, majority control
of the Company could be transferred by one or more holders of Class B common
stock at a time when such holder or holders of Class B common stock do not
have a majority of the economic interest in the Company and with no assurance
that the holders of Class A common stock would be given the opportunity to
participate in the transaction, or if they were permitted to participate in
the transaction, to receive the same amount and type of consideration for
their stock in the Company as the holders of Class B common stock.
In addition, we have elected not to be subject to Section 203 of the
Delaware General Corporation Law, which would otherwise provide certain
restrictions on "business combinations" between us and any person
21
acquiring a significant, 15% or greater, interest in us other than in a
transaction approved by our Board of Directors and in certain cases by our
stockholders.
The Class B Stockholders may compete with us.
The Class B Stockholders are diversified communications providers. There is
no restriction on the Class B Stockholders' ability to compete with us. They
may, now or in the future, provide the same or similar services to those that
we provide.
Some of our directors may have conflicts of interest.
Some of our directors are also directors, officers, or employees of the
Class B Stockholders or their affiliates. Although these directors have
fiduciary obligations to the Company under Delaware law, they may face
conflicts of interest. For example, conflicts of interest may arise with
respect to certain business opportunities available to, and certain
transactions involving, the Company. The Class B Stockholders have not adopted
any special voting procedures to deal with such conflicts of interest. The
resolution of these conflicts may be unfavorable to us. Our Restated
Certificate of Incorporation provides for the allocation of corporate
opportunities between the Class B Stockholders and us.
We will experience a reduction in switched access and reciprocal compensation
revenue as a result of regulatory rate reform.
The FCC has established a framework for the regulation of CLEC interstate
access charges, which has reduced, and will continue to reduce, our interstate
access rates. In addition, the FCC has established an interim carrier-to-
carrier cost recovery scheme for dial-up Internet traffic that has reduced,
and will continue to reduce, the Company's reciprocal compensation. The FCC is
considering replacing the current intercarrier compensation scheme with bill
and keep at some time in the future, which would eliminate the Company's
switched access and reciprocal compensation revenue. Exclusive of the effects
of the recognition of $37.0 million in non-recurring reciprocal compensation,
switched access and reciprocal compensation represented 7% and 6%,
respectively, of the Company's 2001 revenue. The Company anticipates that the
contribution to revenue and EBITDA from these services will decline over time.
We cannot assure, however, that we will be able to compensate for the
reduction in switched access and reciprocal compensation revenue from
regulatory rate reform with other revenue sources or increased volume.
We may complete a significant business combination or other transaction that
could affect our leverage, result in a change in control, or both.
We continually evaluate potential business combinations, joint ventures,
and other transactions that would extend our geographic markets, expand our
services, or enlarge the capacity of our networks. Any material transaction
that we undertake could result in an increase in our leverage or issuing
additional common stock or both, or a change of control. There can be no
assurance, however, that we will enter into any transaction or, if we do, on
what terms.
A change of control could result in a requirement that we offer to purchase
certain indebtedness and the acceleration of other indebtedness. There can be
no assurance that we will have sufficient funds available to make that
repurchase and repay any accelerated indebtedness.
We depend on governmental and other authorizations.
The development, expansion, and maintenance of our networks will depend on,
among other things, our ability to obtain rights-of-way and other required
governmental authorizations and permits. Any increase in the difficulty or
cost of obtaining these authorizations and permits could adversely affect us,
particularly in areas where we must compete with companies that already have
the necessary permits. In order to compete effectively,
22
we must obtain these authorizations in a timely manner, at reasonable costs,
and on satisfactory terms and conditions. In certain cities or municipalities
where we provide network services, we pay license or franchise fees. The 1996
Act permits municipalities to charge these fees only if they are competitively
neutral and nondiscriminatory, but certain municipalities may not conform
their practices to the requirements of the 1996 Act in a timely manner or
without legal challenge. We also face the risks that other cities may start
imposing fees, fees will be raised, or franchises will not be renewed. Some of
our franchise agreements also provide for increases or renegotiation of fees
at certain intervals. Any increases in these fees may have a negative impact
on our financial condition.
Item 2. Properties
The Company leases network hub sites and other facility locations and sales
and administrative offices, many from Time Warner Cable, in each of the cities
in which the Company operates networks. During 2001, 2000, and 1999, rental
expense for the Company's facilities and offices totaled approximately $27.5
million, $15.2 million, and $6.6 million, respectively. In 2001, the Company
terminated an agreement to purchase 24 acres in Douglas County, Colorado, for
construction of a campus for its Denver headquarters. Management believes that
its properties, taken as a whole, are in good operating condition and are
suitable and adequate for the Company's business operations. The Company
currently leases approximately 94,000 square feet of space in Littleton,
Colorado, where its corporate headquarters are located, and approximately
130,000 square feet of space in Greenwood Village, Colorado and approximately
70,000 square feet of space in Englewood, Colorado, where its network
operations center and other administrative functions are located.
Item 3. Legal Proceedings
The Company currently has no material legal proceedings pending.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the quarter
ended December 31, 2001.
23
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
Market Information
The Company's Class A common stock has traded on the Nasdaq National Market
under the symbol "TWTC" since May 12, 1999. The following table sets forth the
high and low sales prices for the Class A common stock for each of the
quarters of 2001 and 2000 as reported on the Nasdaq National Market:
Period High Low
------ ------- -------
2001
First Quarter................................................ $78.125 $35.063
Second Quarter............................................... 55.150 24.500
Third Quarter................................................ 33.800 6.820
Fourth Quarter............................................... 19.500 5.760
2000
First Quarter................................................ $93.000 $39.500
Second Quarter............................................... 80.375 41.000
Third Quarter................................................ 73.750 42.250
Fourth Quarter............................................... 71.750 46.250
Dividends
The Company has never paid or declared any dividends and does not
anticipate paying any dividends in the foreseeable future. The decision
whether to pay dividends will be made by the Company's Board of Directors in
light of conditions then existing, including the Company's results of
operations, financial condition and requirements, business conditions,
covenants under loan agreements and other contractual arrangements, and other
factors. In addition, the indentures for the Company's 9 3/4% and 10 1/8%
Senior Notes and the credit agreement governing its senior secured credit
facility contain covenants that effectively prevent the Company from paying
dividends on the common stock for the foreseeable future.
Number of Stockholders
As of February 28, 2002, there were 258 holders of record of the Company's
Class A common stock and eight holders of record of the Class B common stock.
The Company believes that there are in excess of 18,500 beneficial owners of
the Company's Class A common stock in addition to the record owners.
24
Item 6. Selected Financial Data
Selected Consolidated and Combined Financial and Other Operating Data
The following table is derived in part from the audited consolidated
financial statements of the Company. The financial statements of the Company
for all periods prior to the Reorganization reflect the "carved out"
historical financial position, results of operations, cash flows, and changes
in stockholders' equity of the commercial telecommunications operations of
predecessors of the Company, as if they had been operating as a separate
company. This information should be read in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the audited consolidated financial statements and the notes thereto.
Years Ended December 31,
--------------------------------------------------------
2001 2000 1999 1998 1997
---------- ---------- --------- --------- ---------
(in thousands, except per share and operating data
amounts)
Statements of Operations
Data:
Revenue:
Dedicated transport
services.............. $ 425,401 263,913 152,468 84,024 44,529
Switched services(1)... 312,306 223,421 116,285 37,848 10,872
---------- ---------- --------- --------- ---------
Total revenue........ 737,707 487,334 268,753 121,872 55,401
---------- ---------- --------- --------- ---------
Costs and expenses(2):
Operating.............. 315,682 184,995 117,567 67,153 40,349
Selling, general, and
administrative........ 237,698 170,722 113,389 77,401 54,640
Depreciation and
amortization.......... 207,571 95,295 68,785 50,717 38,466
Restructure
charge(3)............. 6,838 -- -- -- --
---------- ---------- --------- --------- ---------
Total costs and
expenses............ 767,789 451,012 299,741 195,271 133,455
---------- ---------- --------- --------- ---------
Operating income
(loss)................. (30,082) 36,322 (30,988) (73,399) (78,054)
Interest (expense), net,
and other income....... (99,341) (30,409) (28,473) (19,340) 7,398
---------- ---------- --------- --------- ---------
Net income (loss) before
income taxes........... (129,423) 5,913 (59,461) (92,739) (70,656)
Income tax expense
(benefit)(4)........... (48,256) 4,697 29,804 -- --
---------- ---------- --------- --------- ---------
Net income (loss)....... $ (81,167) $ 1,216 (89,265) (92,739) (70,656)
========== ========== ========= ========= =========
Basic and diluted
earnings (loss) per
share.................. $ (0.71) $ 0.01 (0.93) (1.14) (0.87)
========== ========== ========= ========= =========
Other Operating Data:
EBITDA(1)(5)............ $ 177,489 131,617 37,797 (22,682) (39,588)
EBITDA margin(1)(6)..... 24% 27% 14% (19)% (72)%
Net cash provided by
(used in) operating
activities............. $ 197,234 165,259 54,235 (343) (29,419)
Capital expenditures.... 425,452 320,703 221,224 126,023 127,315
Operating Data(7)
Operating networks...... 44 24 21 19 19
Route miles............. 16,806 9,799 8,872 6,968 5,913
Fiber miles............. 758,060 366,990 332,263 272,390 233,488
DS-0 equivalents(8)..... 16,736,000 11,375,000 5,523,000 3,031,000 1,719,000
Digital telephone
switches............... 41 26 19 16 14
Employees............... 2,661 1,834 1,259 919 714
Balance Sheet Data:
Cash, cash equivalents,
and cash held in
escrow................. $ 365,600 250,739 90,586 105,140 --
Marketable debt
securities............. 18,454 3,496 173,985 250,857 --
Property, plant, and
equipment, net......... 1,811,096 912,172 677,106 494,158 415,158
Total assets............ 2,398,954 1,387,754 1,043,012 904,344 438,077
Long-term debt and
capital lease
obligations............ 1,063,368 585,107 403,627 574,940 75,475
Total stockholders'
equity................. $ 948,713 471,767 422,916 207,651 300,390
- --------
(1) Includes favorable non-recurring reciprocal compensation settlements that
totaled $37.0 million in 2001, $27.3 million in 2000, and $7.6 million in
1999.
25
(2) Includes expenses resulting from transactions with affiliates of $17.7
million, $15.6 million, $20.0 million, $27.7 million, and $17.1 million in
2001, 2000, 1999, 1998, and 1997, respectively. See Note 6 to the
Company's financial statements appearing elsewhere in this report for an
explanation of these expenses.
(3) Includes $2.4 million for a non-cash facilities impairment.
(4) During 1999, the Company recorded a non-recurring $39.4 million charge to
earnings to establish a net deferred tax liability associated with the
change from a limited liability company to a corporation. This change
occurred immediately prior to the Company's IPO.
(5) "EBITDA" is defined as operating income (loss) before depreciation and
amortization expense. It does not include charges for interest expense or
provision for income taxes. Accordingly, EBITDA is not intended to replace
operating income (loss), net income (loss), cash flow, and other measures
of financial performance and liquidity reported in accordance with
accounting principles generally accepted in the United States. Rather,
EBITDA is a measure of operating performance and liquidity that investors
may consider in addition to such measures. Management believes that EBITDA
is a standard measure of operating performance and liquidity that is
commonly reported and widely used by analysts, investors, and other
interested parties in the telecommunications industry because it
eliminates many differences in financial, capitalization, and tax
structures, as well as non-cash and non-operating charges to earnings.
EBITDA is used internally by the Company's management to assess on-going
operations and is a measure used to test compliance with certain covenants
of the 9 3/4% Senior Notes, the 10 1/8% Senior Notes, and the Company's
secured credit facility. However, EBITDA as used in this report may not be
comparable to similarly titled measures reported by other companies due to
differences in accounting policies.
(6) EBITDA margin represents EBITDA as a percentage of revenue.
(7) Includes all managed properties including unconsolidated affiliates
(MetroComm AxS, L.P. in Columbus, Ohio and the Albany and Binghamton, New
York networks). Albany and Binghamton were wholly owned at December 31,
1997 and MetroComm AxS, L.P. was wholly owned at December 31, 1999.
(8) Each DS-0 equivalent provides 64 kilobits per second of bandwidth.
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
The following discussion and analysis should be read in conjunction with
the Company's audited consolidated financial statements, including the notes
thereto, appearing elsewhere in this report.
Overview
The Company is a leading fiber facilities-based provider of metropolitan
and regional optical broadband networks and services to business customers.
The Company delivers broadband data, dedicated Internet access, and local and
long distance voice services. As of December 31, 2001, the Company served
customers in 44 metropolitan markets in the United States.
Time Warner Cable (now a unit of AOL Time Warner Inc.) began the Company's
business in 1993. During the last few years, the Company's business has
changed substantially with an exclusive focus on business customers, including
carriers and governmental entities, and a rapid expansion into switched
services and geographic areas beyond the Time Warner Cable footprint.
In May 1999, in preparation for the Company's IPO, TWT LLC was
reconstituted as a Delaware corporation under the name Time Warner Telecom
Inc. The outstanding limited liability company interests were converted into
common stock of the newly formed corporation, Time Warner Telecom Inc. In May
1999, in conjunction with the Reconstitution, the Company completed its IPO of
20,700,000 shares of Class A common stock at a price of $14 per share.
As a result of the IPO, the Company has two classes of common stock
outstanding, Class A common stock and Class B common stock. In general,
holders of Class A common stock have one vote per share and holders of Class B
common stock have ten votes per share. Each share of Class B common stock is
convertible, at the option
26
of the holder, into one share of Class A common stock. Holders of Class A
common stock and Class B common stock generally vote together as a single
class. However, some matters require the approval of 100% of the holders of
the Class B common stock voting separately as a class, and some matters
require the approval of a majority of the holders of the Class A common stock,
voting separately as a class. As of December 31, 2001, the Class B
Stockholders had approximately 93.1% of the combined voting power of the
outstanding common stock.
On January 25, 2001, the Company completed a public offering of 7,475,000
shares of Class A common stock at a price of $74 7/16 per share (the
"Offering"). The Offering generated $532 million in proceeds for the Company,
net of underwriting discounts and expenses. Also on January 25, 2001, the
Company completed a private placement of $400 million principal amount of 10
1/8% Senior Notes due February 2011 (the "Old Notes"). Pursuant to an exchange
offer in March 2001, all of the holders of the Old Notes exchanged their Old
Notes for new 10 1/8% Senior Notes due February 2011 (the "10 1/8% Senior
Notes") with the same financial terms that were registered under the
Securities Act of 1933. The Company used all of the net proceeds from the
Offering and a portion of the net proceeds from the offering of the Old Notes
to repay the $700 million senior unsecured bridge facility that initially
financed the acquisition of substantially all of the assets of GST.
The Company operates in metropolitan areas that have high concentrations of
medium- and large-sized businesses. Historically, the Company has focused its
sales and marketing efforts on such businesses, as they are potentially high
volume users of the Company's services. The Company's revenue has been derived
primarily from business telephony services, including dedicated transport,
local switched, long distance, data, and high-speed Internet access services.
On January 10, 2001, the Company expanded its geographic coverage by
acquiring substantially all of the assets of GST out of bankruptcy. See
"Acquisitions" below. Additionally, the Company activated networks in Chicago,
Illinois; Atlanta, Georgia; Minneapolis, Minnesota; Denver, Colorado; and
Columbia, South Carolina during 2001. As of December 31, 2001, the Company's
networks spanned 16,806 route miles, contained 758,060 fiber miles, and
offered service to 10,685 on-net and off-net buildings in 21 states, including
4,210 route miles, 227,674 fiber miles, and service to 345 on-net buildings in
15 western markets acquired from GST. The Company continues to expand its
footprint within its existing markets by expanding its network into new
buildings. The Company is also selectively interconnecting existing service
areas within regional clusters with owned or leased fiber optic facilities and
has launched on-net inter-city switched services that provide customers the
ability to offer a virtual presence in a remote city.
The Company plans to continue expanding its revenue base by utilizing
available network capacity in its existing markets, by servicing additional
buildings in existing markets, and by continuing to develop and selectively
tailor new services in competitively-priced packages to meet the needs of its
medium- and large-sized business customers. The Company intends to expand its
service offerings on a continuous basis to achieve a diverse revenue base. The
Company's goal is to deploy new services and technologies when technically
proven and when customer demand is evident. As new technologies that enable
the switching of voice calls over an IP and LAN infrastructure are becoming
commercially viable, the Company is integrating this softswitch technology
into its infrastructure. There is no assurance that the Company will bring any
or all of these services to market successfully or profitably.
As part of the process of diversifying its revenue base, the Company is
targeting the expansion of data and Internet services offered on the Company's
existing network. The Company's annual revenue from data and Internet services
for 2001 grew 98% over 2000 and represented 9% of the Company's total revenue
for 2001. The Company expects an increasing portion of its future revenue to
be contributed by data and Internet services.
Due to the impacts of a slowing economy, which has resulted in customers
going out of business, filing bankruptcies, or looking for opportunities to
cut costs, the Company has experienced an acceleration of customers
disconnecting services that has resulted in downward pressure on revenue
performance. In addition, retail customers are taking longer to make buying
decisions, lengthening the sales cycle. During 2001, monthly recurring revenue
of nearly $15 million was eliminated due to customer disconnects and
bankruptcies.
27
Management believes that this pressure is likely to continue to negatively
impact revenue performance for several quarters. Less than 4% of the Company's
monthly recurring revenue at December 31, 2001 was represented by customers
that had filed bankruptcy proceedings. Since December 31, 2001, additional
customers filed bankruptcy proceedings, bringing the total percentage of
monthly recurring revenue from customers in bankruptcy to approximately 5%.
The Company cannot predict how much of that revenue will be lost to
disconnections. In addition, the Company anticipates further disconnections by
other customers due to their optimizing their existing networks, continued
cost cutting efforts, and additional customer bankruptcies or other customer
financial difficulties. Although the Company was able to replace revenue lost
to customer disconnections in 2001 with revenue from new sales, there is no
assurance that the Company will be able to continue to do so.
Factors that could negatively impact the Company's margins in a slowing
economy include below-cost pricing by some competitors to increase short-term
revenue and pressure on long distance rates, both of which represent a
relatively small percentage of the Company's revenue. In addition, pricing
pressure from long haul providers could impact pricing of inter-city point-to-
point services, and the Company has seen intense price competition in common
POP to POP locations in central business districts in certain cities. However,
the Company believes that its margins are improved by its ability to sell
services on its extensive networks that extend beyond these types of highly
competitive routes.
While bankruptcies in the telecommunications and ISP sectors present a
threat to revenue growth, the contraction in the number of providers may
benefit the Company in the following respects:
. as some emerging providers go out of business, their customers may seek
to purchase services from the Company;
. the failure of some emerging telecommunications providers may reduce
some of what the Company believes is artificially low pricing of
services that exists in the market for certain telecommunications
services; and
. the availability of experienced telecommunications personnel may
improve.
There is no assurance that the Company will realize any benefits from the
downturn in these sectors or that the Company will not be adversely affected
by conditions in its market sectors or the economy in general.
Reciprocal compensation revenue is an element of switched services revenue
that represents compensation from LECs for local exchange traffic originated
on another LEC's facilities and terminated on the Company's facilities.
Reciprocal compensation rates are established by interconnection agreements
between the parties based on regulatory and judicial rulings in each of the
states. Several significant agreements expired in 2001 and have been
renegotiated. In most of the states, regulatory bodies have established lower
traffic termination rates than the rates provided under the Company's expired
agreements; and as a result, the rates under the new agreements, while
reasonable in light of the regulatory environment, are lower than the rates
under the expired agreements. In addition, a 2001 FCC ruling on reciprocal
compensation for ISP-bound traffic reduced rates in 2001 and will further
reduce rates in January 2002 and June 2003. The ruling also capped the number
of minutes charged for ISP-bound traffic. Reciprocal compensation represented
approximately 6% of revenue, exclusive of the effects of the recognition of
$37.0 million, $27.3 million, and $7.6 million of non-recurring reciprocal
compensation, in each of 2001, 2000, and 1999, respectively.
Switched access is the connection between a long distance carrier's POP and
an end user's premises provided through the switching facilities of a LEC.
Historically, the FCC has regulated the access rates imposed by the ILECs,
while the CLEC access rates have been less regulated. The FCC released an
order effective in June 2001 that subjects CLECs' interstate switched access
charges to regulation. Effective with that order, the Company's rates were
reduced and will continue to decline over a three-year period to parity with
the ILEC rates competing in each area. In addition, when a CLEC enters a new
market, its access charges may be no higher than the ILEC's. This order does
not affect rates pursuant to contracts between the Company and certain long
distance carriers.
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The Company and several other CLECs have filed petitions with the FCC for
reconsideration of the provisions of the order